Securities Lending: European Trends Spotlight

Featuring: Joseph Gillingwater, Global Head of Fixed Income Securities Finance Trading for Northern Trust Banking & Markets

As featured in the Securities Finance Times European Securities Finance Panel, June 2024 edition.

Securities Finance Times: How do you assess the performance of European securities lending markets over the past 12 months?

Gillingwater: The MSCI Europe index recently hit at an all-time high, with a hard landing recession seemingly evaded. This has resulted in a decline in securities lending activity, with softer short side conviction limiting activity in EMEA. The long hedge fund bias has increased borrower internalisation levels and created a glut of broker-to-broker financing, with attractive swap pricing for borrowers covering shorts synthetically. Borrowers therefore have more cost-effective alternative routes to cover shorts versus a physical borrow. New specials remain scarce across all European markets with a lack of broad sectoral themes, corporate events and IPO’s.

Robust demand has remained in place for highly-rated sovereign debt, mainly core issuance from Germany, France, and the Netherlands. Absent specials activity, and with the recent equity rally, these are typically sought in term upgrade trades, and driven by liquidity ratio and regulatory capital requirements. The specials space has been relatively benign as central banks telegraph economic policy and enact quantitative tightening, subsequently shrinking their bond holdings and pushing assets back into the street.

Securities Finance Times: What pressures and opportunities have recent regulatory initiatives created for your securities lending business? 

Gillingwater: We continue to observe ongoing changes to the regulatory landscape which impact the securities lending industry. However, these have largely focused on enhancing transparency, agility and technology to improve efficiency and resiliency in the industry. For example, the adoption of SEC Rule 10c-1a in the US is aimed at enhancing transparency by increased disclosure requirements, transaction reporting, and compliance oversight, with a requirement for security level transaction reporting.

In terms of opportunities, capital-efficient trade structures remain in focus as Basel III endgame approaches and counterparties look to optimize risk-weighted asset (RWA) consumption. Borrowers may consider ‘smart bucketing’ clients based on RWA, with the most efficient asset owners benefiting from increased flow. Cognizant this will be problematic for less efficient clients to distribute their available supply, initiatives such as alternative pledge structures, central clearing, and alternative forms of indemnification are being developed and implemented to help offset these potential challenges.

Securities Finance Times: The UK government has agreed that the country should move to a T+1 settlement cycle. How is this set to impact the rest of Europe in terms of its infrastructure, and how far behind is the EU in following suit with a shorter settlement cycle? 

Gillingwater: Any move by one of the major world markets to shorten its settlement cycle will have ripple effects. Markets around the world will no doubt monitor the move by the US to T+1 settlement and choose if and when, over the coming years, to align settlement cycles, out of convenience if nothing else.

Making the move is not straightforward and there are myriad considerations for regulators, not least of which is creating an implementation pathway that gives asset managers and owners and everybody else who contributes to the orchestrated ecosystem of a successfully settled trade sufficient time to adapt.

That said, the UK can make a decision to move unilaterally. The UK has a single currency under a single regulator and a single national framework. The EU is more complicated. Change at EU and EEA level needs to consider multiple exchanges in multiple jurisdictions, multiple currencies and timezones (Finland to Portugal/Ireland) and the supranational regulatory vs national frameworks perspective. Given the proven time-to-implementation of past EU regulatory change, the industry might expect T+1 to take some years longer in the EU and EEA.

Securities Finance Times: What investments and adaptations to working practices have you made to sustain and grow your European securities lending activity in this environment?

Gillingwater: Segregated collateral schedules continue to be popular and a common theme with regulatory capital or funding efficiency the main driver. This is largely in the form of agent lenders looking to support capital efficient structures, for example, GMSLA pledge for non-US borrowers or low RWA buckets. Additionally, we continue to actively grow loan volume for those beneficial owners with flexibility and willingness to transact outside the typical indemnity. This is often against a broader collateral profile, for example, convertible and corporate bonds, ABS/CLOs, and lower grade equities, providing borrowers with greater funding flexibility to put idle assets to work, and a significant revenue uplift for our clients.

Securities Finance Times: How do you assess the outlook for European securities lending markets for the remainder of 2024 and into 2025?

Gillingwater: Overall demand remains steadfast for European securities lending activity. New opportunities continue to present themselves through name specific trading and general collateral activity. As central banks start to ease monetary policy we should see new opportunities arise, versus both cash investments and in non-cash collateralised loan activity. With specials activity softer across the globe, Northern Trust continues to seek new initiatives to drive revenue, proactively distributing client supply, optimising term structures and utilizing wider collateral buckets where appropriate. More broadly, we expect securities lending will continue to be a positive revenue generator for our clients throughout 2024 and into next year.

The full panel can be accessed here.